Comment: Collections Must Adapt to Changes in Lending

Consumer lenders have traditionally regarded collections and loan recovery as something of an afterthought. And in less competitive times, a wait-and-see approach to industry changes was an acceptable business practice. But emerging trends today require a much more proactive response. Like almost every business sector in the 1990s, consumer lending is undergoing radical change. The focus is shifting away from selling specific credit products and toward building wider credit relationships with customers. A number of recent developments support this observation. First-time mortgages are now often originated with a built-in home equity line of credit. Similarly, credit cards are being used as an access device for home equity loans, while many auto and home lenders are today pre-approving and issuing credit cards in conjunction with secured loans. In many leading organizations, a strategic objective is to meet the credit needs of borrowers across the spectrum of risk and at each stage of the consumer's credit life cycle. Product considerations are becoming secondary. This trend will affect collections. In the traditional fragmented approach, products are viewed in isolation. But now, collectors must develop more robust integrated systems that provide a global view of the entire customer credit relationship, including relationships with other lenders. Implementing such a strategy requires that collections personnel become knowledgeable about a broader array of collateral and risk types. In a related trend, banks are increasingly targeting higher-risk segments, typically referred to as nonprime and subprime customers. But moving into nonprime is far more complex than just buying deeper. In collections, distinct training, policies, procedures, collections tools, and technology are essential for success in these higher-risk segments. Though nonprime and subprime customers represent higher risks than flawless prime customers, the potential for profit is higher, because higher rates can be charged. Collectors must develop or revise the infrastructure, policies, and procedures necessary to support and successfully implement a subprime lending and collection strategy. Pre-approved loans solicited through direct mail will continue to be a major source of new business. The same can be said of telemarketing, including inbound loan-by-phone processes, which are becoming increasingly important. Although on-line processes via the Internet currently represent a small source of loans, we believe this channel will increase fast. Though all these areas continue to grow, the one source in which we expect a relative decline is the branch lender. With the ease and convenience offered by phone, mail, and on-line applications, fewer customers will go to their local branches. What does this mean for today's collector? First and foremost, the design and organization of collection operations will need to adapt. With a geographically dispersed customer base becoming the norm, managing a distributed, decentralized, nationwide collection organization is not a cost-effective option, particularly in such functions as repossession, foreclosure, and court appearances. So it is increasingly important that collectors build networks of local partners to perform those functions-to foreclose on a mortgage, for example. With less customer information required to obtain a loan, collectors and collection systems will require enhanced fraud detection tools to verify and keep track of customers. Likewise, with a customer base that can span time zones, collection processes that rely on local branch or field personnel will need to change. Internet collection procedures should also be considered. Lenders are under increasing pressure to show profitability for each aspect of the value chain: loan origination, funding, servicing, and collection. Over time, inefficient players will be forced to develop greater scale, become more efficient, or withdraw from that part of the business. The use of technology and modeling techniques to improve profitability and customer relationships is another major trend. Today more organizations are using data-base marketing to determine the appropriate loan solicitations. Behavioral modeling is increasingly used to track customer performance, to manage risk, and to predict behavior. If analytical tools and sophisticated computer models are used, collectors must take steps to closely integrate and coordinate their strategy with current marketing programs. For example, loans to nonprime customers with a lower expected-relationship value might likely be collected differently than high-potential, prime customers. Similarly, customers who are expected to be periodically delinquent might be collected differently from surprise delinquents. Operating within this new paradigm requires a new mindset from collectors-one that reflects a greater willingness to work with any customer that can be profitable, and potentially treating every customer differently. To ensure future success, collectors must be also able to recognize and act upon every sales opportunity. With on-line tools for decision support, lenders can increase their potential to cross-sell. For instance, a credit card can be a natural starting point from which to enhance a lending relationship into mortgage, home equity, or small-business lending. Industry analysts predict continued growth for credit cards over the next three to five years, surpassed in potential perhaps only by home equity lending. Though direct mail solicitation and pre-approved offerings have given this segment a black eye, issuers are today developing enhanced risk-based pricing approaches to avoid similar problems. The practice of treating card customers and products in a stand-alone silo is being revisited, as the monolines rapidly move into additional product offerings. Credit card companies are leading the way in customer segmentation, behavioral modeling, and product diversification. Moreover, many of the modeling techniques that have proved successful in this sector can be leveraged in the sourcing of home equity and small-business loans. For collectors, this requires supplementation of existing skills. Collections information must be systematically incorporated into risk and pricing models. We recommend developing a tool kit for credit card collection agents, and providing them with additional training to help with customer retention and cross-selling efforts. Consumer lenders must take steps to address the following: Risk management. A comprehensive framework encompassing customer solicitation, pricing, underwriting, collections, and recovery will be essential to achieve long-term success. Cost management. Comprehensive and accurate cost information must be readily available across each link of the lending chain. Balancing growth and profit. Historically, the on-off cycles of consumer lending have prevented many players from achieving sustainable success. Going forward, enhanced systems, controls, and management information systems must be developed in order to avoid this inconsistent approach. Compliance. The depth and complexity of regulation make compliance an increasingly critical competency. All these trends will affect the way collections are organized and managed. Though most lenders are still in reactive mode, lenders and collectors must become more proactive in addressing these developments, to capitalize on all opportunities and reach their full potential.

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